Yefei Lu, an analyst at the German Value Investing Boutique Shareholder Value Management, has closely studied the investments of Warren Buffett, Charlie Munger and Berkshire Hathaway. That lead him to write the book “Inside the Investments of Warren Buffett” to analyze the investments.
This interview was done 2020 and is published in a small mini series ahead of the Berkshire Hathaway Annual Meeting 2023.
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We have discussed the following topics:
- Introduction to Yefei Lu
- The Genesis of Yefei Lu's Book & What makes the Book Unique
- Yefei Lu on the best and worst Investments of Warren Buffett
- Patterns in Berkshire Hathaway’s investments
- The addictive potential of Berkshire's businesses
- Yefei Lu on the Coca-Cola investment
- Investing in Burlington Northern Santa Fe
- Which companies might be on Warren Buffett's buy list?
- Closing comments by Yefei Lu
- Thank you & Goodbye
- Disclaimer
Introduction to Yefei Lu
[00:00:00] Tilman Versch: Hello viewers. Welcome back to my channel. I’m happy to have you here again, and as always, I would like to ask you for like, a subscription, and a comment if you have questions or want to add something or want to discuss something I’m discussing in this video. Today, I’m having Yefei Lu from Shareholder Value Management here, and it’s the week before the Berkshire Hathaway annual meeting. As you can see, it’s already decorated for the Berkshire Hathaway meeting. Yefei, what is your background?
[00:00:34] Yefei Lu: Sure. Hi, Tilman, thank you for taking the time, and I’m very glad to be on your channel. My background is actually, from an investment perspective, I am an American and also a German and Chinese, and the beginnings of my investments really happened for me in college. So, in America, when I was studying at Stanford in 2000-2004, I started dabbling into stocks. At that time, investing in just the companies I knew, I mean, in Silicon Valley, of course, there were some companies from there, but also just household names at that time.
But when I kept doing it more and more, when I was actually working out of university, my first job was as a management consultant. I was working first in America and then later in Berlin with a consulting company called McKenzie, but I was spending so much of my free time investing that I thought, what the heck, I should really just be an investor and do that full time, I had a lot more passion for that. So I went back to business school at London Business School and there I studied with a professor, his name was Eddie Ramsden, he’s from the Columbia School, where also Warren Buffett studied, and that’s really my introduction to value investing. That’s when I really learned about fundamental investing, about Graham, about security analysis, both from the Graham perspective of asset value investing, as well as what’s later known as the Buffett style, but really a lot of it is from Charlie Munger. So really a lot of the better-quality businesses was also something I learned a lot about.
And after the experience, really learning about it and investing in 2009 to 2011, I joined a family office in Munich, out of business school, and I spent about two and a half years there before becoming a portfolio manager at Shareholder Value in Frankfurt, where I’ve been working and mostly responsible for some of the investments we make in the ex-German speaking countries area. I speak German, I’m responsible mostly for the non-German speaking countries. And specifically, the companies where I would say have the most expertise are companies in the internet space and also in the health [00:03:20 inaudible] background. Also partly, when I was really looking for high-quality businesses that were moderately priced around 2012-2013 when I first joined Shareholder Value, companies that came to mind at that time that I was really looking at or bought into the portfolio were companies like Google, now known as Alphabet, but also companies like Amazon and Microsoft, who obviously just been from my background also, I looked at quite closely. I’m in Seattle now, so that also makes sense. We’re very close; actually, Microsoft Office is only about 10 minutes from where I am.
I went back to business school at London Business School and there I studied with a professor, his name was Eddie Ramsden, he’s from the Columbia School, where also Warren Buffett studied, and that’s really my introduction to value investing.
The Genesis of Yefei Lu’s Book & What makes the Book Unique
[00:04:03] Tilman Versch: And the reason why I’ve invited you before the Berkshire Hathaway shareholders meeting is your book. This is the German version, what is the title of the English version? In German, it’s called Investieren Wie Warren Buffett.
[00:04:17] Yefei Lu: That’s right, yeah, so the English version, it was first published by Columbia University Press in English, it’s called Inside the Investments of Warren Buffett: Twenty Cases. That was actually the beginning of it. Then FinanzBuch Verlag in Germany asked me whether they could translate it and, of course, because they’re quite a well-known publisher, and I’d really like them to also have it in German, I agreed, and that’s why you have the German version as well.
[00:04:50] Tilman Versch: Why did you write the book?
[00:04:53] Yefei Lu: Actually, that’s a very interesting story. So the beginning of the book was actually not supposed to be a book. When I was working on it in business school, I was trying to do all the research about Warren Buffett’s investment cases, because I just wanted to learn as much as I could about his investments so that I could also become a better investor. I was able to find a lot of books on Warren Buffett, that’s not surprising, like, dozens of books…
[00:05:29] Tilman Versch: I have in the background. You can find some of them. There’s Alice Schroeder and Gisela Baur…
[00:05:31] Yefei Lu: Yeah, exactly. So there are many different books, I’ve read them, but I couldn’t find a book or any source where it had really good concrete financial information, you know, the kind of information we use when we look at a company and make an investment decision ourselves. So, I went on this quest for hunting down all the old annual reports for the investments of Warren Buffett. And I had a lot of help, partly from my professor at London Business School, but partly, just different people – I talked to some fund managers, some in New York, some in Europe, in different places. It’s very funny, there were a few annual reports, it was very difficult for me to find them, like, the Salomon one, because Salomon had gone bankrupt or was liquidated between then and when I was trying to do my research, between 2011 and 2013.
And that’s actually the background of the book. I was just trying to do it as a personal project, but what happened is one of the publishers of Columbia University Press, because it’s a small network of value investors based in this Columbia network and I was part of it, he learned from a mutual acquaintance of mine that I was working on this project. And I was asking everyone whether they had very specific things, like the 1964 American Express Annual Report; I couldn’t find it, I wanted to find it. And he actually got in touch with me and asked me, it sounds like a really great project you’re doing, and he asked me whether I would be interested in making it into a book. And being that it’s the Columbia University Press, I couldn’t say no. At that time, I thought the effort would be, you know, since I’ve already done all the research, I thought there would only be a little bit more effort. And it was completely way, way more effort than I would have ever expected. But that’s kind of the beginning and I, of course, couldn’t say no to Columbia also because of the history.
[00:07:39] Tilman Versch: Yeah, that’s a good argument to not say no.
[00:07:43] Yefei Lu: Yeah, I was honored.
Yefei Lu on the best and worst Investments of Warren Buffett
[00:07:46] Tilman Versch: If you look back on Warren Buffett’s investments, what would you call the best, and what would you call the worst investments he did?
[00:07:54] Yefei Lu: Oh perfect. As everyone knows, Warren Buffett, and also when he was working with Charlie Munger together, made many very good investments, and only a few not-so-good investments, and I’ll come back to the bad ones as well. But in terms of good investments, I think the first thing to remember is when he found what seemed like a good investment opportunity, he really made it count. He really went and invested a large sum, and that’s true when he bought a stake in Coca-Cola, which was about 25% of his portfolio at the time. That was also true when he bought Burlington Northern Santa Fe, some of the investments I wanted to talk about. That was $34 billion at the time, so always, when he invests and sees good chances, he does big deals, and that’s part of the reasons why he became so successful, because when you have a very good investment opportunity, but you only invest a little bit, which a lot of us tend to do. And with UCITS laws, fund managers in Europe are restricted oftentimes. If you don’t make a really big position, then you also can’t make it look like the tremendous returns that Buffett has gotten, so that’s one point.
In terms of good investments, I think the first thing to remember is when he found what seemed like a good investment opportunity, he really made it count, he really went and invested a large sum.
But in terms of the other point, I want to point out for the commonality among the good investments, is that I think he really focused on companies that would be structurally very good businesses, not for one year or two years or even five years, but for the very long term, I’m talking about 10, 20, 30 years. And that’s true when you look at American Express which continued growing because of credit cards and traveler’s checks for another 40 years; or when you look at Coca-Cola, which at the time when he bought it, the products were just becoming international and you could see very clearly the curve, and that also grew. The consumption of Coca-Cola per capita continued growing not for 10 years, but even for 20, 30, and 40 years. And that’s certainly still the case with investments today.
He really focused on companies that would be structurally very good businesses, not for one year or two years or even five years, but for the very long term. And that’s true when you look at American Express.
But from some of the very best ones that I personally like, I think American Express is obviously a very good investment from the perspective that, I feel like it’s one of the first big investments for Warren Buffett that’s defining, in the sense that it’s not, you know when you look at some of the very early deals he did or investments, most of them during the Buffett partnership years before the 1960s, he often bought companies, whether you look at Sanborn Maps or some of the other companies I talk about, I mean, Sanborn Maps or even Berkshire Hathaway itself, the holding company. Those were more businesses where he could clearly see that the price he was paying was below the asset values, the physical assets, and then he would have to either take ownership of the company or liquidate some of those assets, which he did very well with the company called Dempster Mill, or another way – monetize the value of the assets. He couldn’t just invest in it and ride the company and its growth for the next 10, 20 years.
Those were more businesses where he could clearly see that the price he was paying was below the asset values, the physical assets, and then he would have to either take ownership of the company and liquidate some of those assets, or another way – monetize the value of the assets.
And I think American Express was one of the first big cases where he took the opportunity during the Salad Oil scandal at the time, 1964, when he saw that it was a great business that had temporarily a big issue from a reputation perspective and also some liability perspectives, but really was a good company that was going to do very well because of its products for a long time. And it was a big position obviously, very well for many, many years. But I also like it just because it’s one of the earlier versions of when he was already buying good quality businesses. He also paid a fair price for it. It was not below 10 times PE, so I thought that was quite a good one.
I mean, there are so many, but GEICO would be another great investment. That’s really one where, when I think about personally the things I look for in an investment, a company that’s a dominant business within a growing industry, that’s a very [00:12:36 inaudible] I mean, GEICO, just because of the way they did business fundamentally, was a superior product and company versus its peers, so it was gaining market share in an industry, auto insurance, that in the US was a growing business for many years. It’s a business he also understood very well. I think at the time when he bought GEICO at the beginning, they had about 2% market share in the US, and now they’re closer to about 10-12. So you get that effect on top of the effect of the growth of the market. When you’re a dominant player and you have some structural advantages, that’s a wonderful thing, also worked out extremely well, of course.
[00:13:19] Tilman Versch: And the bad ones?
[00:13:21] Yefei Lu: I think bad ones – one of the ones that are always known as bad ones, and I want to be careful by saying bad – I think when you look at a bad or good investment, what I really like and when I talk about it, I’m talking about when you’re looking at making an investment based on all the information at that time, is it a good or bad investment. So in that light, I like those other two cases I just mentioned in terms of American Express as well as GEICO. But on that same metric, US Airways was not necessarily a bad investment, it was just a certain risk profile, but it didn’t play out like he thought, so that’s often known as a bad investment.
I would talk about it a little bit. But I want to shy away from saying that was clearly a bad investment. I mean, when the company was bought in the late 80s, I think it was not apparent that this would not work out. At that time, he was paying, first, an extremely good price for it, I think it was below five times PE; second, the company was growing very quickly for an airline.
Of course, if I go through what happened in the next 10 years, first, yes, the investment didn’t perform as expected in terms of, you know, the returns were not the usual great returns he got on an investment. That’s definitely true. The second thing, let’s just assess what really happened – I think the investment pieces at the time when he bought US Airways, it was called US Air at the time, so US Air when he bought it, was a growing airline, it was growing rapidly, and he had paid a cheap price for it, and it was well managed.
US Airways was not necessarily a bad investment, it was just a certain risk profile, but it didn’t play out like he thought, so that’s often known as a bad investment.
What ended up happening is with the deregulation of the airline industry, there were a lot of competitors that came in, and it ultimately drove down both the pricing and the business prospects of that company. But when you look at before the investment was made, when you look at that investment, you look at the really discounted price; and then you look at the way the business was doing fundamentally, it was fairly consistent. I think, from what I remember, it growing something like eight out of 10 years in terms of revenues, it wasn’t as consistent as I remember on the consistency in growing its income, but it was quite a good company, it was fairly well managed among the big peers. And the result afterward, if you look at the airline industry, airline traffic did go up, so that structural growth driver in terms of more people traveling international – air travel did grow. He wasn’t wrong about that. He just wasn’t able to forecast the deregulation and some of that stuff.
So, what I’m trying to say is at the end of the day, even when you do everything right, the analysis right, and you take the right bets, you’re still going to be wrong some of the time. You hope it’s only two times out of eight if you’re very good as an investor. But in those cases, I would caution away by saying those are obviously the mistakes. I would say the mistakes I worry most about, and I think that’s really what you should look at, is when you’re investing in a company where you clearly don’t have enough information to make that investment, and you just make a bad investment decision.
In that sense, I would say, the argument on US Air, even though Warren Buffett readily admits this is kind of an investment mistake, I would say that you can see both ways; and I didn’t even mention the way he structured the US Air deal. I think there were convertible shares, and I think I talk about it a little bit more in-depth in my book. But in the end, he actually didn’t lose money on it, which is also something most people don’t know; they just think he lost it straight on. He actually didn’t lose money [00:17:34 inaudible] a lot of hassle, a lot of [00:17:38 inaudible] and he ended up not making as good a return, from what I remember.
At the end of the day, even when you do everything right, the analysis right, and you take the right bets, you’re still going to be wrong some of the times. You hope it’s only two times out of eight, if you’re very good as an investor.
Patterns in Berkshire Hathaway’s investments
[00:17:46] Tilman Versch: If you look at the 20 cases you have studied, do you see some patterns in the way Warren Buffett and Charlie Munger invested in Berkshire Hathaway?
[00:17:56] Yefei Lu: Yeah, definitely. I think when I was trying to allude to how Warren Buffett at the very beginning during the partnership years, was investing a lot in companies that I would quantify as Graham-style companies. What I really mean by that is he was looking at companies – the way he assessed investments was based on looking at more asset values and asset place and like [00:18:27 inaudible] the investors, but this is also true for Warren Buffett.
There was progress in the way he developed as an investor, and it was only in his middle years after he closed his partnership, or at the end of the beginning, but also a little bit later than when he first started, that he became more and more involved in investing in the great quality businesses that we now know Warren Buffett for, or where he’s well known for in terms of the good quality businesses. Whether it’s Coca-Cola or whether it’s other businesses that are strong, quality businesses.
I would also say along those lines, over time that became more important for him, and, I guess, I want to be a bit more specific about the years – between 1958 and 1968, he was really running his partnerships, and it wasn’t that he didn’t invest in good quality businesses then, but both because he had a smaller amount of capital just based on what he had in terms of the assets and his personal situation investing, he was able to do more things that later on, one, it became more difficult, but also just from his investment philosophy, he developed into a different direction. So in the beginning, he was doing a lot of, where he took over companies, whether you look at Dempster Mill or some other businesses he owned there, he actually had the ability to do a lot of things people don’t know him well for, in terms of also even specific structured products. He was not completely shying away, I believe, from some of the derivative products either that he structured in a certain way.
But over time, and partly with the influence of Charlie Munger, he certainly moved into more quality businesses really looking at structural competitive advantages, and over time also paying more attention, not to just the fundamental business quality, but also how that quality difference and the mode if you will, or the structural competitive advantage changes or kind of remains for a business over time. So, I think that’s a big gradual investment development also for someone like Warren Buffett.
With that said, I also want to say there are certain things that he never wavered on, that were always consistent in his investment process, whether it was early on or later in his investment cycle. And one of those things is management – having a great management team you can trust and you can depend on, was always a non-negotiable for Warren Buffett. And that’s true early in his investment career, as well as in the middle, as well as in the later years. Even when we talk of one of his later investments, like Burlington Northern Santa Fe in 2010, Matt Rose was the CEO at the time, he knew and he personally held in high regard.
He actually had ability to do a lot of things people don’t know him well for, in terms of also even specific structured products.
There are certain things that he never wavered on, that were always consistent in his investment process, whether it was early on or later in his investment cycle. And one of those things is management – having a great management team you can trust and you can depend on.
The addictive potential of Berkshire’s businesses
[00:22:00] Tilman Versch: I’ve heard from a professor who studied a lot of Warren’s investments as well. He said that Berkshire Hathaway has a certain preference for business that creates a certain addiction in the customer. He named See’s Candies, and Coca-Cola as examples with reference to sugar; but he also mentioned Apple in one of the newest investments, referring to the smartphone which makes people somehow addicted. What do you think about this pattern, what is your take on it?
[00:22:32] Yefei Lu: Yeah, I mean, I think the way I would appraise it wouldn’t be addictive, he certainly likes business where the products have a very strong bind; whether it’s switching costs or just strong brand value or some kind of loyalty that holds the customer to the product. So I would say it more in terms of products that are so good or so valuable in some ways, where you have a strong level of customer loyalty. So, that’s certainly true for businesses that traditionally people always like. Like Coca-Cola or chocolates, and I can say that same thing about Lindt and Sprungli …But it’s also true with certain products when you use products like the ones from Apple where people really feel passionate about or some of the products, I would argue also, with some companies he didn’t invest in, like Google, we use that a lot. I think that’s certainly true, and I would say that’s partly just a reflection of very good businesses that tend to have a very strong proposition of value for the customer.
So, I would argue that that’s generally true for the businesses that great investors all tend towards, and Warren Buffett is certainly no exception, and that’s obviously also good quality. But I know also for a fact, that Warren Buffett doesn’t look at the stocks that are really in the sin area, so I would probably not think that he’s doing it specifically like that in terms of addiction or anything.
He certainly likes business where the products have a very strong bind, whether it’s switching costs or just strong brand value or some kind of loyalty that holds the customer through the product.
That’s partly just a reflection of very good businesses tend to have a very strong proposition of value for the customer.
[00:24:23] Tilman Versch: Yeah, I like the argument, but I wasn’t sure about it, so I was interested.
[00:24:28] Yefei Lu: Yeah, I think it’s generally just in terms of the customer loyalty, it’s generally true for very good products, and usually the quality businesses we look at, even when you look at Burlington Northern Santa Fe or something like that, you might not think of that as like a very – I wouldn’t call it an addiction, but if it’s a very good service, then you tend to use it a lot. When I say I use Amazon Prime a lot for delivery, does that mean I’m addicted to Amazon Prime? I would just say it’s a very strong business proposition that has a very strong customer loyalty, and it’s really about customer loyalty – whether you want to put a word to it in terms of switching costs or a different area. I think what’s really meant by it is really businesses that have strong customer loyalty, and it’s usually a result not of the physical addiction but just of a very good product proposition.
Yefei Lu on the Coca-Cola investment
[00:25:27] Tilman Versch: I think addiction is a good take to start a certain discussion.
But anyway, let’s talk about one of the sweet investments now, Coca-Cola. When did Buffett enter the stock and what was his idea behind buying Coca-Cola, which is still there today?
[00:25:46] Yefei Lu: Absolutely, yeah. Coca-Cola is one of the most famous investments of Warren Buffett of many years because it’s such a well-known company, but it’s also a deal where he held many, many shares for many, many years, and such a fantastic investment. So, it’s definitely one that a lot of people know he made, but some people might not know other details.
Warren Buffett actually bought Coca-Cola around, in late 1988, I believe. And at that time there were two things – if I put the whole company into perspective, there were two things really happening with the company, and also with the economy at the time. So first, in the 70s and 80s, Coca-Cola really had a bit of a competition, it was called the Cola Wars at the time, and it was basically between Coca-Cola and Pepsi Cola, were in a marketing competition where they were discussing who had the better Cola product. And it was the case where a lot of the blind taste tests were showing that Pepsi Cola was more popular with the average consumer than Coca-Cola, and people couldn’t figure out why Coca-Cola was the better selling product, over time, was bigger. But in a blind taste test, when you close the eyes, people always seemed to choose Pepsi and based on that and the marketing around that, Pepsi was very successful in trying to gain some market share, and also doing very well for itself.
And the panic of that or because of that, I think Coca-Cola, I believe it was 1985, decided to, in order to compete directly with that, they couldn’t just let that go, they introduced a new product called New Coke at the time. And New Coke was the product that based on just blind taste testing, it seemed like average consumers on the street preferred New Coke over both Pepsi Cola and the original Cola, so they felt comfortable launching it. But what became very apparent fairly quickly, it was that there was a large number of people, that even though on a blind taste test it seemed like this New Coke product was doing very well, they just preferred the old Coke product. Which became kind of understood overtime after that, was that during blind taste tests, a sweeter product that had more sugar seemed like it was preferred in those blind taste tests, but when you have to drink the whole bottle many, many times, over a week if you drink like ten Colas or something like that, then you actually do prefer something that’s not quite as sweet.
So, because of all the chaos and all the bad news, etc., Coca-Cola, there was certainly a time where the company had negative news flow, or a time where the shares – I think at the time the shares dropped something from over $50 a share to all the way to I think the 30s, and Warren Buffett, I remember, had a cost basis about $44 per share for the purchases of Coca-Cola he made in 1988. So just to give you a perspective, there was volatility because first, there’s this situation at Coca-Cola, and in addition to that, of course, what we shouldn’t forget is that in 1987, there was the stock market crash 1987 that we all know about.
So, between both of those things, obviously, there was a good opportunity for him to enter into that company, which he knew many, many years, and he knew the management team of Coca-Cola very well. I think the CEO at the time was Roberto Goizueta, and also the COO, I think name was Donald Keough. They were both people that Buffett knew, became familiar with, and had in high regard, and so, that’s kind of the setting for purchasing the company.
But if you go more into the details of that investment, not only was it – and I can draw analogies to today, of course – but not only was it, you know, it was a time where it was a good time to buy the company, really what you’re always looking at, and what Buffett always looked at in the future, that’s really where the value is, would this company have a great future? And what you could see at the time to make the investment in 1988 was that even at that time with all this news flow and the 1987 stock market crash, etc., the company fundamentally was doing very well.
If you look at the years 1977 to 1987, that 10-year span, it had grown revenues from about $2.7 billion to about $8 billion at that time, so a significant increase. And the income was growing even bigger. At 330 million, and it was 1977, and it had grown to something around 900 million, so three-fourth of that by 1987. So, you had a company that was doing very well fundamentally – if you look at what was really happening with the company, they had just started its international expansion into countries like Mexico and all these countries that, where today actually, more Coke per capita is drunk than even in the United States or in developed countries.
So he had extremely good financial data that the company is doing very well, yet extremely good operating data that said wherever people launch this product, people drink more and more of it, and you can depend on that kind of growth curve over years because you saw that in the US, and then you see it in other countries growing. I mean, I can make an analogy with like, if you look at a company today when Amazon just launched in the US and it works, that business model like Amazon Prime, and then you launched in Germany, even though it’s not profitable in Germany, there’s probably a higher likelihood that that business model also works, based that it does work in the US than if you’re just trying a brand new business strategy in a different country.
At that time really in Coca-Cola, you just had the beginning of an international expansion that had a very high likelihood of working out positively, so you had all this growth that was going to come in, and at the same time, you were able to buy at a fair price, it wasn’t cheap. I think he paid about 14 times his earnings for it, but you could pay a fair price and buy this company because of the situation with the New Coke and with the situation around the stock market crash. So, it was a wonderful investment.
It was a time where it was a good time to buy the company, really what you’re always looking at, and what Buffett always looked at is the future, that’s really where the value is, would this company have a great future?
Investing in Burlington Northern Santa Fe
[00:33:22] Tilman Versch: So let’s jump to another crisis where he was very active. We already talked about it in another video with your colleague, was the investment in 2007-2009, it’s Burlington-Northern. What was the idea behind this investment?
[00:33:44] Yefei Lu: Yeah, sure, I think Burlington Northern Santa Fe was also a defining investment – one because there was a private investment where he took the whole company over, but also because at that time, just raw monetary amounts for really getting into very large, double-digit billions is really big business, right, at that time. First, I think what a lot of investors maybe don’t know, the complete story is that he didn’t just buy the whole company at once, he actually invested into Burlington Northern Santa Fe in two different tranches, if you will. And his first investment into the company was already in 2007, so before the financial crisis. In 2007, he had already accumulated about 17% of the company, which I think trickled up to a bit over 20. I believe that was about 22% before he took over the company in 2009, I think it was late 2009 beginning of 2010.
So, when you look at it in Vorhinein – or a priori, what you saw, Burlington Northern Santa Fe was a wonderful business. It was wonderful in the sense of it had extremely consistent growth in revenue, and growth in net income; but more important than that, again here, and I always stress this, in terms of data you find, that’s one of the things I really feel like is very strongly a defining character of Warren Buffett’s investments – the amount of high-quality data you have to really make a good investment decision. And here with Burlington Northern Santa Fe, you always had operating data for both Burlington Northern Santa Fe, but also its largest competitors like Union Pacific, that were published every month by the American Association of Railroads. And if you look at that, you have very clear data, it was doing very well, and it was doing better than its competitors in terms of revenue ton-miles, and all the kinds of train operating metrics.
So, based on that, and also Matt Rose being such a good CEO, and that being a good business, Warren Buffett essentially invested in the company already in 2007. It was already a good enough investment or business to warrant an investment. And I think one thing I just want to stress is really when I say a good business, I also really mean [00:36:22 inaudible] prospects for structural growth over a very long time period. And one of the defining things about railroads, especially for product transport, is that it’s one of the most efficient ways to transport large amounts of goods over long distances. It’s something a magnitude more efficient than trucking, which is the most common modality of goods transport in the United States.
So, you had good data that over time, more and more products were going to train transport, but it was happening very slowly, and I think Warren Buffett, and as we should as well, should like anything that’s consistent and maybe not too quick, that’s a blip. So you also had this structural growth component inherent in it of a modality of transport for goods that were just more efficient and more cost-effective per revenue ton-miles than the other common forms of travel with large trucks being the most common form, I think in the United States.
So based on all that, he has invested already in 2007, and then when the stock market crash happened in 2008-2009, at that point, again having a good entry point, but already having all the information and already feeling comfortable with that investment case, he had the opportunity to buy out the entire or the remainder of the shares he didn’t own, about the 78% that was remaining, and he paid a premium for that as I’m sure most people could read about also in the news. I think at the time, the lows I think that the shares were Burlington Northern Santa Fe when it was still trading, even went below $50 and Warren Buffett took over the company at $100 a share, so paying $34 billion. But it was a very good investment, I think even at that price, I think the price he paid, it wasn’t dirt cheap, I think he paid something like 16 times the earnings of that year, but it’s a fair price for such a business that’s going to grow for such a long time, that’s really the backbone of the American kind of industry.
And at that time, you also have to put it into perspective, like I was saying before, in his early years when he only had, let’s say, at one point only 10 million, and then a 100 million to invest, it’s a different ball game than when you had to invest with a $100 billion, which was the case already at this time. Now, it’s even much more than that, but at that time, we’re already looking at that kind of sum and there are only so many companies that you could acquire can make a difference when you’re already that big, and based on everything there was, I think it was definitely a good price to pay for that investment.
And one of the defining things about railroads, especially for products transport, is that it’s one of the most efficient ways to transport large amounts of goods over long distances.
So, you had this structural growth component inherent in it of a modality of transport for goods that was just more efficient and more cost-effective per revenue ton miles than the other common forms of travel in the United States.
[00:39:38] Tilman Versch: Do you have any numbers on what was his return on this investment?
[00:39:44] Yefei Lu: So there are some numbers you can kind of infer a bit from the reports, but what you know is also comparable. I mean, Union Pacific is still a well-known but publicly traded company, and if you look at the shareholder returns for that company, I think that was trading something like $26 before or $50, and now it’s I think 270 or something. So you had something like a 5x increase even in the competitor that was doing a little bit as well. So, the returns were extremely good. It’s certainly true that the returns were better in aggregate than it was even if you invested in Berkshire during that time period. And that’s not even to mention the dividends that were paid out during that time from that company, which are in the tens of billions of dollars, I think it’s something like – I have to go back and look at the numbers, but something like between $20 and $30 billion, I believe.
Which companies might be on Warren Buffett’s buy list?
[00:40:55] Tilman Versch: So let’s go through the current crisis we are in, and maybe guess a bit – which names would be your guess you can find on Warren Buffett’s watch list, and maybe which names would be closer to buy currently or in the near future for Warren?
[00:41:14] Yefei Lu: Well, I think that’s an extremely difficult exercise to make. I’ll venture to [00:41:23 inaudible] but just venture, I guess, on two fronts. First, I think you shouldn’t forget that some of the companies Warren Buffett look to invest in, most of the time when he’s looking at investment, either there’s a phone call and he gets an offer of a business that he kind of knows, or it’s a company he’s been following for a very long time. So some of those investments are clear, like in the Burlington Northern Santa Fe case, companies he already owns, and he might buy more of. And I think we talked about Apple, we talked about some of those companies. If there is a right price, I’m sure some of these companies where he has already done the research so to speak, would be really on the top of his list.
Other than that, you’re really looking at very large companies with products and also growth that is going to do very well over the next few years. So I don’t want to venture to say any specific names here and there, but certainly, I would say, those are companies where you don’t have too much debt, you don’t have too much in terms of a shareholder structure or management team, where the case is very iffy, I think you will always find those cases where it’s the ones he’s already kind of been in contact with. I have some names in mind, but no, I don’t want to go out and say this or that. I think he knows, but I think there are two things.
The second thing I wanted to note, actually he’s come out and I think Charlie Munger has also spoken a little bit in the last few weeks about this, they’ve been quite conservative so far, first – they want to make sure they survive and thrive through this crisis and holding quite a bit of cash still; and second – I think one thing that just happened in the back of my mind, but I think a lot of people probably don’t know is, a lot of times, the best investment cases or investment opportunities actually arise not at the exact moment of the crash, but in the early years of recovery. And that’s partly to do with, in the early years of recovery, you already know it’s getting better and things are getting to the right place, so you don’t have the risk of this falling knife or this uncertainty of how bad is this crisis going to be. By that time, it also becomes a bit clearer which are the companies that are clearly going to benefit from this crisis, and walk away in five years, in 10 years much stronger.
So I believe that that’s something where it’s not like everything is over, I think you really need to do a lot of research and try to pick out the winners of the future, kind of, in the early recovery. And I think Warren Buffett is a very patient man, we can all learn from, and it’s very important to then go out and try to find what you’re also trying to find when it’s not crisis time. You’re trying to find this really great quality business that can grow over time. That’s not changed, that’s still the same. But if you can get it at a specifically little bit better price or a fair price, that’s a goal, because a lot of times these best-in-class businesses, when I talk to my colleagues or with myself, it’s not on an average day that they even become fair price, they usually are trading quite expensively. So I think that’s going to be the overall kind of what we should look for, and that’s some indication of what he may do.
Most of times when he’s looking at investment, either there’s a phone call and he gets an offer of a business that he kind of knows, or it’s a company he’s been following for a very long time.
A lot of times, the best investment cases or investment opportunities actually arise not at the exact moment of the crash, but in the early years of a recovery.
Closing comments by Yefei Lu
[00:45:16] Tilman Versch: For the end of our interview, I want to ask you a classical question at Berkshire: do we have something to add to the things we’ve discussed here?
[00:45:26] Yefei Lu: I think we covered quite a bit. I just want to stress one factor that’s often talked about a lot, but people end up still forgetting, because they find out some business or some kind of specific product, or sometimes even because just growth is very good, but I think one thing that is very important, especially when you’re a long-term investor, and I should always take the opportunity to stress that, and it’s really a core part of Warren Buffett’s investment philosophy is really make sure the managers for business are something you really pay attention to. I mean, the thinking of Warren Buffett was always, you’re investing in a business where you are part owner in the business. If you’re part owner, then you’re going to care about who is owning or managing your business, so you need to have that personal connection. I’m not saying you have to go and meet that person [00:46:25 inaudible] for dinner or something, but make sure you have a kind of honest investor-manager who’s steering your company, and also just the management team that both, is honest and integral, but also is capable. And I think those are two things you really need to always keep in mind when investing.
Make sure you have kind of honest investor-manager who’s steering your company, and also just the management team that both, is honest and integral, but also is capable.
Thank you & Goodbye
[00:46:52] Tilman Versch: Thank you for these nice final remarks, and thank you for your time and sharing your knowledge and wisdom. Thank you.
[00:47:00] Yefei Lu: Yeah, thank you very much as well, Tilman, and I’m very glad we could have a talk.
[00:47:07] Tilman Versch: Have a great stay in Seattle, and hope to see you soon one day again in Germany.
[00:47:12] Yefei Lu: Sure, very soon I hope, speak to you soon.
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